5 Keys To Master Trading Psychology

I was just a speaker on a Twitter Space hosted by Gav Blaxberg of Wolf Financial (a recommended follow by the way) and got the opportunity to discuss market psychology with a few great folks who all operate on many different timeframes.

I was pleasantly surprised with how similar we all viewed the subject of market psychology. In this article, I’ll share my thoughts on the subject and my 5 Keys to Master Trading Psychology.

Before we get into it, make sure you are subscribed to Trading Engineered so you don’t miss any future posts.

Trading and investing come down to very simple actions of clicking buy or sell on different instruments. However, anyone who is involved in the markets knows that being successful in the markets is anything but easy. Much of trading occurs behind the scenes with the analysis of fundamentals, technicals, and any other information that makes you decide whether it’s worth the risk to buy a particular stock.

These decisions are often complex and because there is a significant risk of losing money, emotions run high and many people act based only on impulse. There is a lot of self-applied pressure to perform and “beat” other investors or the indexes.

When it comes to this type of pressure, I find trading very similar to sports. In order to deal with a tournament final or some other big game or event, the key is to put in the work beforehand and set yourself up for success.

A great example is running a marathon; in order to run well, you need to put in the time and hundreds of miles before you even line up at the starting line. It is the same thing with trading—you need to prepare properly before the morning bell rings.

Key 1: Write Trading Rules

For a beginner trader or investor, I strongly believe that sitting down one weekend and establishing a base set of rules that will govern your actions is one of the absolute best things you can do.

As I have mentioned before, I will be creating a whole series just around rules (so make sure you are subscribed) but in general your trading/investing rule set should cover & address the following:

• Your long term financial goals

• Description of your timeframe

• Market Conditions

• Stock Selection

• Buy Conditions

• Position Management

• Position Sizing

• Risk Management

• Routines

• Post Analysis

If you don’t have a set of rules and you are not getting the performance you want, ask yourself: Would a set of defined rules make me a more disciplined and effective trader?

If the answer is yes (which it should be) you need to sit down and do the work.

Key 2: Establish Routines

Routines should always be part of your trading rules, but when it comes to market psychology, they are so important that I wanted to highlight them specifically.

From my experience on Twitter and YouTube, many people out there are looking for shortcuts, the next stock tip, price targets, or the perfect screen/indicator. Again, the hard truth is that there are no shortcuts when it comes to finding the best setups. If you want to be trading/investing for the next few decades, you need to develop your own process and routines that identify high potential setups for your style.

This all starts with your weekend routine. You need to evaluate your positions, the market, and identify promising setups for the week. Entries, risk, stop losses, position sizes can all be determined on the weekend.

With everything figured out, you will be much calmer during the week because you should have already visualized everything that can occur. Then it’s just about responding to what actually happens and following the plan you already laid out.

Routines and rules are both proper habits you need to form in order to treat trading as a business. Again, I want to reinforce that the top athletes get to those highest levels because of consistent high-quality practice and preparation.

Key 3: Reduce Noise and Avoid FOMO

Negative and positive emotions are echoed and amplified by being on social media. When it comes to trading, this is the opposite of what you want if you want to stay even-keeled.

You should also NEVER be taking a trade simply because it was mentioned on Twitter or by a friend. That person may have already entered, they may operate on a different timeframe, manage risk differently… the point is that you need to own and hold yourself accountable for every trade and make it your own. Own your results, study yourself, and develop a feedback loop that allows you to constantly refine your process.

How are you going to develop a process that you can use for decades if it is dependent on someone else’s work for ideas? If everyone locked themselves in a room for three months and focused only on themselves they would be better traders.

Along those same lines, I like to focus my attention during the week and the day so I am only watching stocks I am prepared to enter. Watching other names like a SPAC going crazy at best just distracts you and at worst can suck you into a trade you are not prepared for. 

Focus your attention and operate within your area of competence.

The market provides new opportunities every single day. If you missed an entry, wait for a new one to set up—your account will thank you. Twitter and other social media can be great sources of information and educational resources, but you must avoid becoming dependent on them.

Key 4: Protect Your Emotional Capital

The keys I’ve mentioned previously all tie into this; you need to protect your mindset and your emotional capital. The main way I do this is through thorough preparation.

Protecting your confidence allows you to take the risks necessary to perform well in the market. If you have taken a big loss or are experiencing a lot of stress outside of the markets (see the next section) you are more likely to ignore your rules and take outsized risk or sell at the wrong moment.

For trading, the best way to protect your confidence is to take small losses before they cascade into larger ones. For investing, you can use position sizing as well to limit total losses within your portfolio. The key is to manage risk properly.

Everyone has a different risk tolerance, but you need to ensure you don’t let any losses get out of hand. Some risk management guidelines to follow are:

• Never average down on a position when the market is showing you that you are wrong.

• Keep losses per position under 1% of total capital.

• Set a stop loss right after you buy a position.

• As a stop makes a profit for you, trail your stops and protect your breakeven point, and then your gains.

• Never revenge trade after a big loss to try to make back your money. Take some time off and reflect on how you can improve.

These guidelines are designed to limit losses and protect your financial capital, but they will also preserve your emotional capital at the same time by keeping your account near all-time highs and limiting drawdowns.

Key 5: Take Care of Your Health and Wellbeing

This is actually the most important part of the equation. You will not be able to operate at your highest ability when trading if you are sick, stressed, or otherwise distracted.

My worst week in the markets was when I was trying to trade during some very important final exams. I wasn't focused on the markets and took some bad trades just to feel involved. This only compounded my stress and if I had just left my account alone that week my performance in both my classes and in the markets would have benefited.

This year, I took an extended trip across the country visiting national parks and I realized I wouldn’t be able to trade much. Instead of staying fully invested I sold down to core positions and just looked at my positions near the end of the day.

This not only kept me in some strong positions but also let me enjoy my trip without worrying about the market. Taking a step back from the markets is sometimes the best thing we can do to improve performance. Remember, the goal with trading/investing is to build wealth, not spend your life in front of a screen.

I would fully encourage every market participant to take up a serious outside hobby that gets them away from your computer. Music, reading, hiking, sports, whatever you enjoy... make sure you take the time each day and week to have fun. Personally, I play soccer four times a week, go rock climbing & hiking, and hang out with friends. I find exercise especially lowers stress and keeps me focused.

The peace of mind you will enjoy by doing things you love will translate into improved performance when the morning bell rings.

Key Takeaways

Your main takeaway from this article should be that by being prepared and disciplined you will naturally decrease the stress you experience and protect your emotional capital. Be calm, follow your rules, and operate from a position of strength by keeping your drawdowns low.

And most importantly, remember to live your lives and do things you love to do outside of trading. Life is for living, not just trading, and by staying healthy and happy you will automatically put yourself in the right mindset to trade/invest according to your rules.

I hope you enjoyed this! Feel free to share this article on Twitter or with a friend if you think it would help them.

Have an awesome weekend!

Richard